Fourth tier: It’s almost a derogatory phrase in some quarters, with a few cigarette manufacturers taking pains to disassociate their low-price brands from the baggage that may come along with the term. Often populated by nonparticipating manufacturers (NPM) of the Master Settlement Agreement (MSA), some with fly-by-night reputations and all with bottom-barrel pricing, that original fourth tier had its heyday in the early part of this decade.
Fast forward to 2010, and it may be safe to argue that this old, Wild West tier of cigarettes barely exists anymore.
“Unfortunately, in some ways, what everybody said would happen actually happened,” says Lou Maiellano, a tobacco consultant with TAZ Marketing & Consulting Group, Sevierville, Tenn., and, who, as a former Sunoco tobacco category manager, embraced the sales opportunity of low-price cigarettes. “The pressure with the allocable share actually put a lot of these companies out of business.” Maiellano, of course, refers to allocable share legislation being implemented by many states that increases NPMs’ payments into the MSA, ultimately raising the price of their product and eliminating their competitive advantage. He points to numbers from the cigarette sales quarterly The Maxwell Report, showing fourth tier’s share of cigarette volume in 2004 at 10%, while it fell to 7.4% by 2007.
But while the “the day of the fourthtier renegade, nonparticipating manufacturers … is disappearing,” says Maiellano, “there is a shift where volume has moved to discount since the federal excise tax (FET) [increase].” He again citesMaxwell Report data, showing how volume share for the savings category of cigarettes has grown from 27.8% in 2008 to 29.5% as of secondquarter 2010.
Essentially, the former fourth tier has morphed into a reputable low end of the discount category, Maiellano suggests. And what was once the playground of regional brands has seen interest from national giants. Promotions by the majors—particularly Reynolds American’s heavy focus on Pall Mall and Altria’s Marlboro discounting— have obscured the lines between the price tiers and charged up the level of competition among the value brands [CSP—April ’10, p. 95].
“There is a major trend change in the ‘value’ segment,” concurs Rick DiDonato, vice president of sales for JT International USA (JTI USA), Teaneck, N.J., via e-mail. JTI USA offers Wave and the new Wings brands of discount cigarettes. (See “Wings Takes Wing,” above.) “Traditionally, the value segment was comprised of discount brands with regionalized distribution, usually manufactured by smaller manufacturers with limited sales organizations,” he says. “We are now seeing major brands … that are being sold at value-brand prices because of specific promotional programs at retail.”
This strategy is creating a new level of competition in the value or discount sector, says DiDonato: “When a consumer can purchase a nationally known brand for the same price as a ‘discount brand,’ competition intensifies. When the major manufacturers in the U.S. enter this price segment, it’s clear that this is where a significant number of adult consumers are shopping.”
CHAIN REACTION
L.R. Gardner, vice president of The Crackerbox Food Stores, a chain of 29 sites based in Hot Springs, Ark., has seen the shift first-hand. One month prior to the April 2009 FET increase, Arkansas bumped its cigarette excise tax by 56 cents per pack. The result, says Gardner, was a stampede toward the fourth tier. “Once somebody decides to trade down, they trade all the way,” he says. “They don’t stop in the middle at a second- or third-tier cigarette—they go all the way to the bottom.” Crackerbox’s fourth-tier sales rose by double digits, with the majority of the increase coming from Pall Mall.
While many may consider Pall Mall a third-tier brand, Gardner says Reynolds discounts it heavily in Arkansas, making it a fourth-tier option for smokers. He considers any cigarette that sells for $4 or less per pack “fourth tier”; by that measure, Crackerbox’s other offering in the segment is Liggett Vector Brands’ Grand Prix.
In response to the strong sales, Crackerbox has expanded the number of Pall Mall and Grand Prix SKUs by about nine apiece, although Gardner doesn’t feel motivated to bring on additional brands for fear of diluting his sales. Premium and generic sales, meanwhile, dropped off, leading the retailer to remove some nondiscounted premium and generic SKUs.
Before MSA, Crackerbox, which is under contract with Reynolds and Altria, had dabbled in fourth-tier brands from nonparticipating manufacturers. But after MSA, that all changed, Gardner explains.
“Most of those really cheap brands can’t cover MSA, so they go out of business,” he says. “As prices went up, for us, it became more important for continuity of the brand than just having this cigarette today and then tomorrow not having it. You can’t build any brand loyalty on that.”
At the same time, the fourth-tier customer is doing a subtle financial balancing act, he observes. “The fourth-tier-cigarette guy has a tendency to buy perhaps more items but spend less money,” says Gardner. “He will buy fourth-tier cigarettes and buy a sixpack of beer instead of a 30-pack of beer. Or he may buy a 30-pack of beer, but that causes him to buy the fourthtier cigarettes.”
It’s partly this focus on price that has demonstrated to Gardner the need to keep all of the segments in perspective. “You market fourth-tier cigarettes but you focus on premium cigarettes, because that’s where your margin is,” he says.
PICK AND CHOOSE
Scott Lojas, merchandising manager for The Hartley Co., Cambridge, Ohio, which operates 23 Starfire companyops in eastern Ohio, can attest to the power of brands. Hartley added JTI USA’s Wave and Wings and Commonwealth Brands’ Sonoma after going off contract with a major cigarette manufacturer. “One of the reasons we got away from contracts is the way they dictate to us and the slow payment of money,” says Lojas, pointing out that the stores lost the equivalent of six cartons per week as a result, which he considers minimal. Hartley is currently on contract with Altria, JTI USA and Commonwealth. Lojas estimates that one-fifth of his 300 cigarette SKUs qualify as “fourth tier,” saying, “I consider Wave, 1839 and Sonoma fourth-tier, and other people consider them third-tier.” After the passage of the FET increase, Hartley saw some erosion in premium volume, while generic or second-tier sales fell precipitously. “But growth came mostly in fourth and third tier,” he says.
Choosing the ideal low-price assortment has been tricky, Lojas admits, partly because he is not a smoker, but also because brand preference seems to vary widely by geography. Thus, he’s taking a trial-and-error approach. “By giving consumer choice and seeing what sells, it helps,” says Lojas.
“The key point this year is just keep watching fourth tier grow and see where it goes and see what customers are asking for,” he says. He also checks out his competition’s assortment. “I’m trying to work with manufacturers to maximize sales.”
In terms of a goal for fourth tier, the retailer says it’s tough to set one for a category that is in continual, slow decline.
“Anytime I’m able to bring something in, whether it’s fourth-tierr premium, I think it’s worthwhile,” he says.
Wings Takes Wing
Best known for its Wave discount brand and Export ‘A’ superpremium brand, JT International USA (JTI USA) is expanding its low-price offering with Wings, which officially went into distribution in June. While Wings may seem like a lower-price alternative to Wave, the brands actually serve two different customers, according to Rick DiDonato, vice president of sales for the Teaneck, N.J.-based company.
“Wave is a brand that offers the same characteristics as a premium brand, such as sweepstakes, rounded-corner packaging and direct-toconsumer communications, yet offers them at a value price point,” says DiDonato via e-mail. “Wings is more of a traditional value brand for the price-conscious consumer.”
The Hartley Co., dba Starfire, Cambridge, Ohio, is under contract with JTI and brought Wings on board in July as a stable, low-price bookend to its cigarette set.
“I was looking for a fourth tier, what I consider a true fourth tier,” says Scott Lojas, merchandising manager. “There have been so many different cigarettes coming and going. I wanted something that would be here for a while and be price competitive.” By adding Wings, Hartley earned an additional buydown on Wave. JTI does not consider Wings a fourth-tier cigarette; it instead categorizes it as a lower-price value brand. Although it is still early in its rollout, “the results are very encouraging,” DiDonato says, with the supplier ahead of its distribution targets for the brand.
Of course, while JTI hopes retailers will find room for both Wave and Wings, it acknowledges that space is at a premium in the cigarette set, says DiDonato.
“We try to help our retail customers make the best use of their space by asking a few questions, such as: Is there more space dedicated than what current contracts require?” he says. “Are there lower-level options of participation available from manufacturers that have underdeveloped or declining shares? Are there SKUs that occupy space that are no longer selling? Can the space dedicated to the category be expanded?”
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